Farmland investment: A cautionary tale

• Right now, investors are looking at several farm-related opportunities.

• In some respects, these investments are lucrative.

• On the other hand, they may be setting us up for a 1980s flashback — a trip back into one of the most painful periods of U.S. farming history.

Dear Mr. Farmland Investor:

If you’re thinking about investing in agricultural land, you should think long and hard.

Right now, investors are looking at several farm-related opportunities. In some respects, these investments are lucrative. On the other hand, they may be setting us up for a 1980s flashback — a trip back into one of the most painful periods of U.S. farming history.

Remember the 1980s movie sensation “Back to the Future?” Let’s hope it’s not the 1980s.

Agricultural farmland investment can be profitable. However, it’s also risky and should be carefully considered.

Farmland Ownership

In the view of some, farmland ownership offers a host of opportunities — or does it?

That all depends on several factors — what’s produced, whether the farm has government program base acreages, it’s location, and, most important of all, whether there is any competition for renting the land.

Other factors must be considered too. For example, is the land associated with livestock or row crops? Each has its own risks and rewards. Both, during certain times, face tremendous market volatility. In some cases, cropland tied in with fruit and vegetable production offers lucrative opportunities. But returns can be high or low, depending on the vagaries of the weather and markets. Droughts, floods, tornadoes and, in the case of Southeastern farming, hurricanes are risks faced by farmers.

How does one make money as a farmland owner?

Farmland owners have the option of renting on a cash-rent or crop-share basis, though cash rent remains the most reliable revenue source. Crop-share arrangements are riskier because the owner, along with the producer, must bear any production shortfalls that may occur due to weather or other risks.

Also remember that on a crop sharing arrangement it’s the owner’s responsibility to store and sell his or her share of the crop. Sometimes it’s better to store a couple of months; sometimes it’s better to sell right away. In any case, the owner bears the risk of marketing the crop. Farm cash rent payments are a possibility, but has its risks too.

Government program payments

What about government program payments? Under the 2008 farm bill, a landlord who rents on crop shares must also “materially participate” in the farming operation to qualify for government program payments.

Other requirements also apply. Check with the Farm Service Agency when exploring that option. Moreover, farm program payments are capitalized into the value of farmland, so expect to pay more for that land.

Also, bear in mind that farmland value will vary depending on soil type, fertility, location, topography, history of crop production and other factors. All of these factors need to be carefully considered.

Yes, farmland is hot right now. Demand is high. Institutional investors such as MetLife have jumped into it.

All of this seems lucrative at the moment, but what happens if commodity prices decline precipitously as they did in the 1980s? What happens when institution investors conclude that farmland is no longer as hot an investment? This could be a train wreck in the making.

Commodity Ownership

Commodity ownership as a crop-share rent landlord is not a bad strategy, providing one is aware of historically volatile markets and production risks.

There are no guarantees that prices will go up or stay up or even that a crop will be produced. Bad weather can result in zero crop and significant livestock death, though some of this risk is mitigated through crop insurance.

What about marketing? Be aware that it’s possible to lose a great deal in the futures market — the reason why novices should shy away from futures. Purchasing puts and calls or hedging physically owned commodities are less risky.

Writing options can be disastrous if you don’t know what you’re doing, and even if you do, it’s still considered extremely risky. Some futures investors have experienced financial ruin.

Farming

Farming is risky business. The capital investment to get into farming is huge. A 1,000-acre cotton farm operation may require equipment purchases exceeding a million dollars. This doesn’t include additional purchases for plants, fertilizers, insecticides, herbicides and fuel, to name only a few.

All things considered the costs to operate a 1,000 acre cotton farm may run as high as $2.5 million.

Spiking oil prices have only added to these costs.

After all this, if you’re still interested in farmland as an investment, consider talking to someone who’s farmed for a long time, preferably someone who successfully weathered the farm crisis.

Yes, farming can be a profitable and satisfying lifestyle, but as any experienced farmer will attest, it’s not all peaches and cream.

It’s great — and profitable and satisfying — if you’ve got a crop to sell. If you don’t, well, just remember that the bills won’t stop coming.

(James L. Novak is an Alabama Cooperative Extension System economist and Auburn University professor of agricultural economics.)